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J  cc -- Since 1996, the World Bank has reached more than 6 million poor in Bangladesh
through microfinance projects worth over US$260 million.

90% of micro-credit borrowers are women.

Micro-credit borrowers have used the funds to start small grocery shops, set up trading activities, rear
cattle and poultry, farm fish, and start up businesses such as tailoring, rickshaw pulling, paddy husking,
among other activities.

Micro-credit has significantly helped improve their lives:

{ 99% report   , often by more than 15%

{ 96% report 
   
{ 99%   
 food
{ 99%    
{ 86%    
{ 88% are now able to 

  
{ 83% have better   
{ 55% of rural borrowers now   

* Data based on an assessment of the impact of microcredit on a sample of borrowers carried out in 2001.

!  "   "

In 2002, an innovative World Bank project, Financial Services for the Poorest, extended micro-credit to
the poorest of the poor, who couldn¶t qualify for conventional micro-credit programs (such as beggars,
sex workers, or household help ). The project was initially piloted in 18 districts covering 20 Upazilas in
Bangladesh, reaching 60,000 of the poorest people. Around 12,500 borrowers received job skills training
to become gainfully employed. Most of them are now gainfully employed.

The government replicated the project all over Bangladesh and as a result:

{ Around 450,000 of the poorest of the poor have benefited

{ Repayment rate has been more than 95%
{ Already 20,000 of those who received micro-credit 3 years ago can now access regular rural
microcredit programs
{ More than half of these borrowers no longer live on less than a dollar-a-day. They have also
upgraded their housing conditions from ³©
X to semi-durable structures within 3 years
 #
  
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The first World Bank Poverty Alleviation Microfinance project (1996-2000) expanded the outreach of
ongoing successful microfinance programs and enhanced the institutional and financial sustainability of
Palli Karma-Sahayak Foundation (PKSF) and its Partner Organizations (POs).

Palli Karma-Sahayak Foundation (PKSF) is an apex microfinance institution that reimburses microcredit
loans of its Partner Organizations (POs) and their borrowers.

Prior to Bank assistance in 1996, PKSF financed the microcredit activities of 124 POs through loans
outstanding of Tk.459 million to 300,000 borrowers.

Today, PKSF is financing 212 POs with loans outstanding of over Tk.10 billion to around 6 million
borrowers.

The PKSF Board includes leading personalities, such as Nobel Laureate Dr. Yunus. Moreover, Bank
support to PKSF has helped leverage funds from IFAD, EU, ADB, USAID, and DFID.

The Second Poverty Alleviation Microfinance project reached a greater number of poor people,
diversified micro-credit to include the urban poor and microenterpreneurs, built sustainable institutional
capacity of PKSF and its POs, and established a legal and regulatory and supervisory framework for non-
government organizations and microfinance institutions.

This project reached around 350,000 urban poor, and 60,000 microenterpreneurs who graduated from
the regular rural microcredit programs. The average loan size has increased to Tk.7,800 signifying that
bigger loans are made to repeat borrowers who are expanding their economic activities, increasing their
incomes and improving their livelihoods.

The impact of microcredit continues to grow as borrowers increase their loan amounts and as new
borrowers take microcredit for the first time.

Social indicators relating to health and education of microcredit borrowers also continue to improve as a
result of continuing the microcredit programs.

Given the project¶s success, the Bank is processing a proposal for additional US$15 million to provide
microcredit services to an underserved segment of the urban poor, mainly the rickshaw pullers affected
by the ban on non-motorized transport on certain Dhaka roads.
‘
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¦ &' cc' -- Last week, the Nobel Peace Prize went to Muhammad Yunus and Grameen Bank, the
microfinance institution he founded 30 years ago.

The World Bank interviewed Syed Hashemi, a senior microfinance specialist at the Consultative Group to Assist the
Poor (CGAP), who assessed the award¶s impact on the microfinance industry. Before joining CGAP, Hashemi, a
Bangladeshi national, directed Grameen¶s Program for Research on Poverty Alleviation.

        

(

"I think first of all it will remind all of us who work in microfinance that our work is indeed about improving people¶s
lives. That the Nobel committee has chosen to recognize this is really an honor for the entire industry, especially
microfinance practitioners in developing countries worldwide. And no one is more deserving than Professor Yunus.

I had the good fortune of working closely with him for several years at Grameen, and I can echo what the entire world
knows about him now -- that he is a tireless champion of the poor and has dedicated his life to this work. He has been
an inspiration to me personally and to literally millions of others, including the more than six million clients of
Grameen Bank itself. Their achievements -- and Grameen¶s role in supporting them -- will now take center stage in
the debate over how best to attack and conquer poverty.

I think the Nobel really underscores that microfinance is no longer a niche development field, but has become part of
the financial mainstream."

)   


 
*  +c  (

"The original Grameen business model -- group lending, and mostly to women -- has been adapted and developed by
thousands of microfinance institutions from Latin America to Africa to East Asia and beyond.

But microfinance today is also about much more than small loans. It¶s about providing a full range of financial
services, like safe places to save and transfer money, to ever-larger numbers of poor people. And it¶s being done by
much more than donor-funded NGOs.

Microfinance has actually matured into one of the most successful and fastest-growing industries in the world. In
Africa alone, its growth is probably second only to that of cell phone use. According to a recent analysis conducted by
CGAP, the compound annual growth rate of the world¶s leading microfinance providers over the last five years has
been an incredible 15 percent. Worldwide, these leading microfinance institutions are nearly twice as profitable as the
world¶s leading commercial banks."

      

    *(

"When Professor Yunus gave his first loan to a group of women in Bangladesh, that act was about confronting
systems of inequity and exclusion. It wasn¶t out of a development playbook somewhere or out of a commercial bank¶s
operational manual. In fact, Professor Yunus himself has said that he deliberately did the opposite of what
conventional banks did; if, for example, a traditional bank client had to go to a branch, Grameen instead brought the
branch to the client. That kind of bold grassroots effort built much more than a single microfinance institution; it built a
movement.

The movement has quite literally changed the face of Bangladesh. For one thing, women have become visible,
productive, assertive members of society. If this seems like an overstatement, consider that Grameen and other
microfinance trailblazers like BRAC have branches in tens of thousands of villages across Bangladesh."

       


(

"It¶s no secret that small loans to poor people, especially women, can support micro-enterprises, helping families
boost their incomes. But poverty is about much more than the lack of money; it¶s multidimensional. Over the long run,
access to finance -- loans, but also savings and money transfer services -- has been shown to contribute to better
nutrition, education, housing, and other essentials.

Poor people with erratic incomes can also manage their consumption better and cover the costs of medical or other
emergencies. But proving the direct impact of a micro-loan on the health or education of a poor person is never a
straightforward task, which is why it¶s important not to think of microfinance as the "magic bullet" when it comes to
poverty alleviation. It¶s one of many strategies, but it can lead to empowerment and social stability, as the Nobel
committee has acknowledged."

)   J  ,*"-  (

"As a global organization, we remain focused on the central challenge of microfinance today: reaching the nearly
three billion people who still lack access to financial services. Getting there will take partnership with a wide range of
stakeholders -- including commercial banks, telecommunications companies, and other private players -- that can
help us adapt existing payment systems and technologies like cell phones to reach massively larger numbers of
people. It¶s also important to remember that many of these people are in remote areas, some of them at the very
bottom of the ³economic ladder.X Helping these people reach the first rung of that ladder will take some innovative
thinking. At CGAP, for example, we¶re working with social safety net programs in several countries to see if we can
³graduateX some of their beneficiaries into microfinance programs and out of absolute poverty."

’
‘‘
 "   *  
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" !  J.2001/203/SAS ‘ ‘
, ".
In Dhaka: Ismet Zerin Khan 880-2-966-9301
E-mail: ikhan1@worldbank.org
In Washington: Zita Lichtenberg (202) 458-7953
E-mail: zlichtenberg@worldbank.org
www.worldbank.org/developmentnews

#)  / &0 cc&--The World Bank has approved a US$151 million credit for a project to
improve and expand micro-lending in Bangladesh. The 
"   $
"% aims to increase access to credit and ensure sustainability of the country's micro-lending
programs. The credit is provided by the International Development Association (IDA), the World Bank's
concessionary lending affiliate.

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The project follows an earlier $105 million IDA credit provided in 1996. The first micro-finance project
helped provide micro-credit to about 2.2 million borrowers by the time it closed on December 31, 2000.
The project has had a strong impact on poverty by helping to stabilize income and consumption,
improving quality of life (through increased access to clean water, and better health and hygienic
conditions), increasing school enrollment rates, and enhancing family assets. It has improved financially
the viability of partner NGOs who retail microcredit, enabling them to seek part of their funding needs
from the financial market as well as allowing their gradual integration into the formal financial sector.

The project aims to:‘

{ † 


 , responding to unmet demand and the need for larger loans per borrower. ‘
{ † 




 


 

, including providing smaller loan sizes, flexible
repayment plans and possibly linking micro-credit to safety net programs such as skills training and food
aid.
{ † 
 



 where current micro-credit is limited to less than 15 percent of
urban poor people, as compared to over 60 percent of rural poor people. The potential for growing out of
poverty through micro-credit is high in urban areas because of proximity to large markets.
{ 
 



 to help them scale up their activities and in turn create
employment for the poorest people.
{ a  



, including the Palli Karma-Sahayak Foundation (PKSF), the
organization set up by the government to administer funds, and its partner organizations (NGOs and
micro-finance institutions) who on-lend the funds to individuals.

The project will also help the government design a regulatory and supervisory framework which will
improve credit-worthiness of NGOs and micro-finance institutions and accelerate their integration into the
formal financial market.

Partner organizations have estimated an expansion of around 4.5 million borrowers in the next five years.
The Bank-sponsored project is projected to reach an estimated 1.2 million new borrowers and support
19,500 micro-entrepreneurs.

The US$151 million credit to the Government of Bangladesh is made on standard IDA terms with 40
years' maturity. The government will on-lend the IDA funds to PKSF at 1 percent for 20 years, with five
years' grace. PKSF then re-lends to its partner organizationseligible micro-finance institutionsat interest
rates ranging from 4.5 to 7 percent. The partner organizations will be free to set the final lending rates to
the beneficiaries (expected to be in the 25-30 percent range--which reflects administrative costs). Total
project costs are US$181 million with the Government providing US$ 30 million.
‘
‘
’
‘‘
† 
*  J*¦   

‘ ‘
       

Bangladesh has made striking progress on a range of social indicators over the last 15 years ± an
achievement which is credited to the country¶s pluralist service provision regime, including the large network
of NGOs. A recently released report by the World Bank titled µEconomics and Governance of NGOs in
Bangladesh¶ recognizes these contributions and addresses the current debates surrounding NGOs.

4  J*¦    

   
  
. For instance as the
following chart shows almost half the students
in NGO primary schools are from the poorest 20%
of the population far higher than in other schools.

4          

 
  
  
  5 For instance micro-credit programs
that now reach around 70
percent of poor households, have led to significant
improvements in female empowerment and led to
greater stability of incomes for the poor. Educational
and health outcomes have improved for NGO
beneficiaries due to social sector programs. NGO
advocacy campaigns have also led to greater
awareness, and some progress, on pro-poor issues. Hence the rapid growth of NGO activity over the past
decade is a positive development. Moving forward, NGO services will need to be scaled up even further as
NGOs can have a critical impact on Bangladesh¶s PRSP targets.

4   
 J*¦      
  
    &67  &00c$0 
67   &00$cc6. At the same time micro-finance interest income and profits from commercial
ventures have become increasingly important for NGOs. The scaling up of NGO activity will require different
sources of funding depending on the type of service provided. The micro-finance sector has matured to the
point where the sector ought to move towards commercial sources of funding. In the social sectors, there is a
strong case for financing of NGO programs through
the Government Budget, using donor funds or
domestic revenue. However in order for this to be
effective in practice, contracting procedures need to
improve significantly as part of an overall
strengthening of Government procurement. For
advocacy type work, financing sources ought to be
independent of Government, raised from private
donations or external grants. Several NGOs have
established commercial enterprises whose profit
stream is earmarked to support their development
programs. This µendowment model¶ is an innovative
solution characteristic of charities elsewhere.
However NGOs should incorporate such
businesses as independent entities to create a level
playing field with the private sector.

2 
    1      J*¦       8
-   * J*¦
 
 5 The implicit compact would be where each
actor strengthens various areas that are within their own mandate. The combined impact of these
improvements will go a long way in achieving the common goal of improving services to the poor in
Bangladesh and help achieve the Millennium Development Goals.

As part of this compact, the     * is to facilitate the provision of quality NGO services
under a modernized regulatory framework, developed in close consultation with NGOs. The regulatory focus
should change from government micro-management of NGOs¶ foreign funds to support for better corporate
governance, strengthened accountability, and transparency by NGOs. Moreover regulatory reforms for NGOs
need to be linked closely to the new micro-credit law under consideration. The framework should recognize
that NGO advocacy fulfils an essential function in a democracy such as Bangladesh, and must be given
space, except for activities that promote one political party, or election candidate, over another. Regulatory
capacity must be strengthened significantly ± one option is that Government set up an independent NGO
Commission to perform many of the current regulatory bodies¶ functions. Government ought to strengthen
contracting procedures to improve the effectiveness of aid that is channeled to NGOs through the Budget. As
part of this lessons from PKSF¶s successful NGO contracting procedures could be mainstreamed within
Government. The Government-NGO Coordination Council (GNCC) ought to be revived to provide a forum for
regular Government-NGO discussions.

# should continue to support NGO activities in Bangladesh, both to improve pro-poor service delivery
and to promote a broad-based civil society, while ensuring that they do not undermine the accountability of
NGOs to Bangladeshi stakeholders. Moreover donors need to be accountable for the occasions when poor
project design or inadequate supervision contributes to unsatisfactory implementation of projects involving
NGOs and institute mechanisms to prevent these from reoccurring. While financing social sector activities
donors also need to develop a clear strategy for sustainability, as has occurred in micro-finance. This strategy
ought to be developed in tandem with Government and NGOs where in the medium run the Budget
progressively absorbs the costs of financing of various social sector programs. In areas such as advocacy,
where the conflicts of interest with Government financing are significant, donors could work with NGOs to tap
the market for greater private charitable contributions. Donors should also reduce the transaction costs of
their financing by harmonizing reporting requirements, upgrading financial management skills of their own
staff, and retaining ³institutional memoryX within their organizations.

J*¦ also clearly have an important agenda in front of them if they are to continue to be effective partners in
development. Priorities include the need to (i) strengthen financial management and corporate governance;
 (ii) scale up efforts to provide public disclosure with respect to financial and programme information along
with a public information strategy to address misconceptions about NGOs (iii) make greater efforts to
coordinate with local and national Government officials and act as facilitators of Government, private sector
and community service provision (iv) revisit strategic directions periodically based on national development
needs and internal capacity constraints (v) develop a middle management layer to oversee more complex
development programs.

Clients may also support the strategic compact using mechanisms that improve their capacity to demand and
monitor services, for example, through vouchers enabling choice between public, NGO and private providers.

May 2006

_____________________________________________________________________________
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9
THE VOLATILE COMBINATION OF PROFIT-SEEKING MICROFINANCE COMPANIES, MINIMAL COMPETITION,
AND VULNERABLE BORROWERS HAS OPENED UP DANGEROUS POTENTIAL FOR EXPLOITING THE POOR.
THE 2,!¦,!†#24 INDUSTRY NEEDS TO BE REGULATED-THROUGH POLICIES THAT ADDRESS
TRANSPARENCY, )2*) 2J4†!†4 !4†, AND ABUSIVE LOAN RECOVERY PRACTICES.

SINGE MUHAMMAD YUNUS pioneered the concept of microcredit in 1976 and founded the Grameen
Bank in Bangladesh, microcredit has become a major movement. Worldwide, 3,552 microcredit
institutions provided loans to 155 million clients, finds the State of the Microcredit Summit Campaign
Report 2009. Grameen Bank alone disbursed more than $5 billion in microloans over the last 10 years,
and it now has 7.7 million borrowers. According to the Grameen Bank website, microcredit is "offered for
creating self-employment for incomegenerating activities and for housing for the poor, as opposed to
consumption." The poor are expected to invest the microloans to start up or grow a microbusiness and
thus climb out of poverty. Microcredit is the latest silver bullet for alleviating poverty.‘

In his popular 2005 book Fortune at the Bottom of the Pyramid, CK. Prahalad argued that there is much
untapped purchasing power at the bottom of the pyramid (BOP), and that private companies can make
significant profits by selling to the poor, while simultaneously bringing them prosperity. Focusing on
efficiency and low default rates, Prahalad cites microcredit as a good example of the BOP proposition.
And indeed, in the past few years hundreds of for-profit companies have begun financing and marketing
loans to the poor in developing countries. But, in an ironic twist, private companies are making a fortune
in microcredit by doing exactly what microcredit was designed not to do: exploit the poor. "Now poor
people are turning into one of the world's least likely sources of untapped profit, primarily because they
will pay interest rates most Americans would consider outrageous, if not usurious," wrote BusinessWeek
journalists Keith Epstein and Geri Smith in a December 2007 article. MFTransparency, a selfmonitoring
microfinance industry association, finds that private companies have been attracted to microcredit "by
near-monopoly lending environments and misleading pricing systems compounded by borrowers'
frequent lack of understanding of the financial details of credit transactions."1

Whether fair or not, a few recent -profile events have galvanized criticism of microfinance institutions
(MFIs). When Banco Compartamos in Mexico went public in April 2007, the- initial investors' stake of $6
million was valued at $1.5 billion - a return of roughly 100 percent a year compounded over eight years.
This profitability is due to the fact that Compartamos charges   that exceed 100 percent
annually on their loans to the poor. Yunus was particularly critical of Compartamos, telling BusinessWeek,
"
 was created to fight the moneylender, not to become the moneylender."

In the Indian state of Andhra Pradesh more than 200 people committed suicide, allegedly because of
intimidation by MFIs. Government authorities closed down 50 branches of two major MFIs in 2006 and
charged them with exploiting the poor with usurious interest rates and intimidating the borrowers with
forced loan recovery practices. Y.S. Rajasekhara Reddy, chief minister of Andhra Pradesh, was quoted in
The Times of India as saying, "MFIs were turning out to be worse than moneylenders by charging interest
rates in excess of 2 o percent."2 And over the past few years, there has been growing criticism of MF I s
by government officials and politicians in Bangladesh, Cambodia, India, Pakistan, and Sri Lanka.

I argued in an earlier article in this magazine that microcredit does not significantly alleviate poverty (see
"Microfinance Misses Its Mark" in the summer 2007 issue of the Stanford Social Innovation Review). The
vast majority of microcredit clients are caught in subsistence activities and compete in overcrowded
markets. They usually have no specialized skills, hire no paid staff, own few assets, and operate on too
small a scale to achieve efficiencies, and so they do not earn enough to rise out of poverty. In March 20
09 the World Bank published Moving Out of Poverty, one of the most thorough field studies of the
dynamics of poverty based on narratives from 60,000 poor or formerly poor people in 15 countries of
Asia, Africa, and Latin America. The study notes an "important insight" that "the tiny loans usually
provided under microcredit schemes do not seem to lift large numbers of people out of poverty."

Regardless of this debate, microcredit has grown dramatically in the last 30 years and become
increasingly commercialized. The volatile combination of profit-seeking companie s, minimal competition,
and vulnerable, ill-informed, and ill-educated borrowers has opened up dangerous potential for exploiting
the poor. There is a dire and immediate need to regulate microcredit to protect poor borrowers.
DENY THE PROBLEM

One response of the microcredit industry to mounting criticism has been to deny the problem. In a June
2008 open letter to critics, Carlos Danel and Carlos Labarthe, the co-founders of Compartamos, write, "In
an open and free market, we are convinced our clients are in the best position to make the right choices
for themselves and their families." 3 The first problem with this assumption is that the microcredit
organizations do not operate in free and competitive markets. They are actually often quasi-monopolies.
The Consultative Group to Assist the Poor (CGAP), a consortium of development agencies and private
foundations dedicated to promoting microcredit, states, "In most countries, the microcredit market is still
immature, with low penetration of the potential clientele by MFIs and little competition so far." 4 Nimal
Fernando, a microfinance specialist working for the Asian Development Bank, concurs: "In many
countries in the region [Asia], the majority of microcredit is provided by a few leading institutions, and
competition among them is mostly on non-price terms."5

Later in their open letter, Danel and Labarthe concede that 
 is not a competitive market. They
justify their bank's    and  profitability on the grounds that they "wanted to build an
industry ... to draw in investors and competition." The promise is that "competition will make for more and
better products at better prices in the future." This is a rather disingenuous defense of exploiting the poor.
Let's follow the argument: Exploitation today will enable future competition that will then reduce
exploitation, (So the monopolists exploiting the poor today are doing a service for tomorrow's consumers
.) By this logic, we should be grateful to the loan sharks of past centuries for charging usurious intere
st  that have attracted 
 firms to the market.

The second and bigger problem with the free market argument is the assumption that microcredit clients
are rational economic actors. Even in a rich country like the United States, there are laws to protect
financial services customers. Since the 2008 economic crisis, there has been a strong push by the
Obama administration to increase consumer protection with, for example, the Credit Card Accountability
Responsibility and Disclosure Act of 2009. The Obama administration in July 2010 created an
independent agency, the Consumer Financial Protection Bureau, with broad authority to protect
consumers of financial services from abusive, deceptive, and unfair practices. The administration justified
regulatory reform on the grounds that "financial products are complex, and it is often difficult for even the
most financially astute consumers to recognize the risks financial products can present." 6 If financial
literacy is a problem in the United States, it is a much bigger problem for microcredit clients in poor
countries. In fact, poor people are often illiterate and innumerate. The adult illiteracy rate in India is 39
percent, and clearly much higher among the poor. This problem is exacerbated for microcredit clients who
are overwhelmingly female and have an even higher illiteracy rate.

There are very few empirical studies on financial literacy, especially in developing countne s. A survey of
clients of two micronnance organizations in India found, not surprisingly, very low levels of financial
literacy.7 The great majority of the respondents could not identify the interest rates on their loans (due in
part to a lack of transparency, which I will discuss below) . The survey also found that only 17 percent of
the respondents were able to solve the arithmetic problem "divide 8,0 00 by 10," and only 3 percent of
respondents could solve the problem "multiply 4,500 by 18." Given such low levels of numeracy, it is
difficult to see how microcredit clients can make good financial choices, such as comparing two loans with
different terms.

The 
 industry has tried to downplay the problem of consumer exploitation. In a February 2009
paper CGAP argues, "It is a mistake to assume that Compartamos'   are typical of the
industry, or even a substantial part of the industry." 8 But should we wait until exploitation has become
pervasive before implementing consumer protection regulation? There are laws against stealing, even
though most people are not thieves. In developed countries there are laws resulating loan recovery
process, even though abusive practices are not widespread. Moreover,    are not as
rare as CGAP implies . By their own analysis, 5 percent of 
 loans worldwide are at 
higher than 50 percent per year; and this does not take into account fees and compulsory savings
that significantly increase the effective  . Lack of transparency is almost universal. Chuck
Waterfield, microfinance expert and founder of MFTransparency, argues that the true price
of 
 loans has "never been accurately measured nor reported. . . . This is hard to imagine and
even harder to explain." 9 Regulation of the 
 industry must focus on three issues: lack of
transparency,   , and abusive loan recovery practices.

LACK OF TRANSPARENCY

At a Microcredit Summit Campaign conference in July 2008, MF-Transparency was launched as the
industry's policeman. Since then, 183 industry leaders have endorsed the organization. On its website, M
F Transparency states its reason for forming: "Due to complications of market conditions and lack of
regulation, the true price of loan products has never been accurately measured or reported." M
FTransparency's phrase "complications of market conditions," however, seems to be a euphemism for
market failure.

The effective interest rate that a borrower pays for microcredit is very different from the stated interest
rate of the loan. Microcerdit organizations routinely hide the actual interest cost by using "creative"
practice s, such as charging interest on the original value of the loan rather than on the declining balance;
up-front fees; collection of a security deposit (deducted from the loan amount); compulsory savings
(collected with loan installments); and charging an insurance premium. With such hidden charges it is
common for the effective annual interest rate to be more than 100 percent, when the stated interest rate
is only 15 percent.

Subrata Mitra, finance professor at the Indian Institute of Management Calcutta, describes a typical Indian
MFI loan of 1,000 rupees (Rs) with an annual interest rate of 17.5 percent due in 47 weekly installments .
The total repayment would be 1,175 Rs at 25 Rs per week. But there would also be a security deposit of
10 percent of the loan deducted up front and refunded with 5 percent interest at the end of the year, as
well as an insurance premium of 2 percent deducted up front. The borrower would also be required to
save 10 Rs per week for one year at 5 percent interest rate.10 With these terms, the effective annualized
interest rate is 121 percent compared to the stated interest rate of 17.5 percent. Given the low levels of
numeracy and literacy, let alone financial literacy, it is impossible for microcredit clients to compare two
loan products with a plethora of confusing terms.

The 2009 book Portfolios of the Poor applauds MFIs for charging up -front fees as a good way to reduce
risk. In fact, up -front fees and the other complicated terms serve only to reduce the effective amount of
the loan and to increase the effective interest rate charged, which increases the MFI's profits but does no
good for the poor. It is ironic that the savings feature of microcredit loans is touted as serving the poor's
savings needs. The poor clearly need savings facilities, but bundling together savings with microcredit in
a non-transparent manner is ineffective and unethical. If the security deposit is increased to 20 percent in
the loan example above, the effective interest rate jumps to 194 percent per year.

An essential condition for an open and free market is the ability to compare competing products, which
requires pricing transparency. Regulation is needed that mandates microcredit organizations to explicitly
state the effective interest rate calculated using a standard and prescribed approach, and to describe all
the loan terms simply.

HIGH INTEREST RATES

Criticism of the 

 industry for charging    s has intensified in recent year s,
especially with the growth of for-profit MF Is. A paper published by CGAP argues, "It is fair to criticize an
MF Fs   as unreasonable only if its profits or some controllable element of its costs is
unreasonable."11 This is happening: 2 , profits, and controllable costs are
unreasonably  for a significant part of the 
 industry - and the need to regulate an 
 cap for 
 is imperative.
Based on data from 555 sustainable MFIs in 2006, the above CGAP paper shows that the
median   is 2 8 percent per year. Even this number is understated because it does not
include the impact of compulsory savings, which increases the effective cost of the loan to the borrower.
Yunus argued in 2009 that if the 
   is more than 15 percent above the cost of
funds, then it is "too . ... You are moving into the loan shark zone." Generously allowing 10 percent
for cost of funds implies that more than half of MFIs charge   that Yunus would consider
too . In SubSaharan Africa and Latin America, 5 percent of MF Is charge   above 70
percent; around the world, 5 percent of MFIs charge   above 50 percent per year. Although
Compartamos'   exceeding 100 percent might be exceptional,   exceeding 50
percent are certainly not rare.

Many MFIs are very profitable. In the C GAP study, MFIs earned 2.1 percent return on assets annually,
which is well above the 1.4 percent earned by banks in the same countries . MFIs are usually not as
highly leveraged as banks, thus lowering their return on equity. In spite of this, 10 percent of worldwide
microcredit loans earned return on equity above 35 percent in 20 o 6. These are high profits by any
business criteria. The CGAP study concludes that MFI profits are high because "the microcredit market is
still immature, with low penetration of the potential clientele by M F Is and little competition so far."
Monopoly rents and vulnerable consumers are the cause of high prices and profits in microcredit.

The industry response is that the high interest rates are due not to high profits but to high costs. Because
of fixed costs in servicing a loan, it is proportionally more expensive to service a microloan than a larger
loan. Moreover, the poor infrastructure in developing countries leads to high costs. But this argument is
not consistent with empirical evidence. In a July 2009 analysis of 22 MFIs in Mexico, Waterfield shows a
very wide range of loan prices - from 38 percent to 90 percent - within similarly sized loans.12 Analysis of
48 MFIs in the Philippines and 31 MFIs in Ecuador yields similar results. As Waterfield's analysis holds
the loan size and environment constant, the price differential is likely due to local monopoly power, which
leads to  profits. Costs measured by operating expenses as a percentage of loan portfolio also vary
widely - ranging from 25 percent to 55 percent - for Philippine MFIs with similarly sized loan products.
Once again, since this analysis controls for loan size and the environment, the cost differential is likely
due to some MFIs having unreasonably  controllable costs. In Bangladesh in 2006, the state-backed
wholesale funder of microfinance publicly voiced concerns about poor borrowers having to pay 
  because of inefficient MFI operations. In a competitive industry, such wide differentials in
costs and prices would not persist, and firms with inefficient operations and  prices would be
penalized. This is further evidence that 
 is a monopolistic industry, and regulated 
 caps are needed urgently.

Fernando argues that interest rate ceilings will reduce the availability of microcredit.13 A CGAP paper by
Brigit Helms and Xavier Reihe concurs that interest rate ceilings "often hurt rather than protect the most
vulnerable by shrinking poor people's access to financial services." 14 The flaw in this argument is the
assumption that microcredit is a competitive industry. Price controls in a competitive industry will lead to
reducing supply; but that is not true in a monopolistic industry. Setting an appropriate interest rate ceiling
will actually expand the availability of microcredit, given the monopolistic nature of the industry. This
should not be difficult, since the gap between the competitive and monopoly price today is so big.

ABUSIVE LOAN RECOVERY

Microcredit is also coming under increasing criticism for its debt collection practices. Although there is no
systematic evidence, there is anecdotal evidence that some MFIs use coercion to enforce loan
repayment. In Kalihati, one of the first Bangladeshi villages to benefit from Grameen's low-interest credit
scheme, the villagers who have taken out a loan are unable to reimburse their credit and claim to be
harassed by Grameen Bank representatives. Korshed Alom, a former debt collector, was put into early
retirement for questioning Grameen's methods. "Their technique is to scare borrowers and insult them,"
he told France 24 in a June 4, 2008, report on microfinance. ' We tell them to sell their clothes, that they
have no other choice. Fm not proud of myself, but several times I had even been obliged to say, 'Sell your
children.'"15
Some MFIs in Andhra Pradesh were charged with intimidating borrowers with forced loan recovery
practices. According to a Jan. 8, 2008, Wall Street Journal article, one delinquent borrower was violently
beaten by a thug working for a collection agency that was hired by ICICI Bank. The Delhi Consumer
Commission fined ICICI for what the judge called "the grossest kind of deficiency in service and unfair
trade practice." In Mexico, clients of Azteca who slipped behind on repayment received frequent visits
from motorcycle-riding collection agents, according to a Dec. 13, 2007, BusinessWeek article. Much
microcredit relies on group liability. Sometimes the coercive practices are undertaken not by the MFI but
by the group members.

Exploitation can occur even without an MFI using coercive loan recovery practices. All that is needed is
for the borrower to believe coercion will be used. A survey of clients of two microfinance organizations in
India finds that 53 percent of respondents believed "it is all right" for an MFI to confiscate assets such as
cows, house, land, and machinery if the borrower is unable to repay the loan.16 This is particularly
disturbing because the crux of microfinance is uncollateralized lending. The survey results do not imply
that assets are in fact confiscated by the MFI in the event of default, but the perceived threat of
confiscation (or any other threat) is in itself intimidating and abusive.

ALTERNATIVES TO REGULATION: TOO LITTLE, TOO LATE

The potential for consumer exploitation in the case of 

 is a direct result of market failure. This
failure is due to two underlying causes: first, too little competition; many MFIs exercise significant market
power that results in very   . Second, the consumers of 
 are ill informed,
which allows MFIs to be non-transparent in loan terms and engage in abusive recovery practices. When
the profit-maximizing behavior of firms in a free market results in negative consequences to public
welfare, constraints need to be imposed. Constraints can be achieved through four approaches:
corporate social responsibility, self-regulation by the industry, activism by civil society, and government
regulation.

Many MFI proponents do acknowledge the problems of consumer exploitation but do not like the solution
of regulation. They plead with microcredit organizations to act more ethically, or argue that the industry
should regulate itself. These responses are at best naively optimistic and will not work.

Commercial organizations given opportunities for increasing profits usually act in their self-interest. In a
Jan. 20, 2005, survey on corporate social responsibility (CSR), The Economist magazine concluded that
for most public companies, "CSR is little more than a cosmetic treatment." Appeals for self-restraint on
the grounds of ethics and values have not been effective in the business world, and there is no reason to
believe commercial microcredit organizations will be any different.

An appeal on ethical grounds is complicated by the fact that industry participants do not agree on a
common set of values. A group of leader s in microfinance signed the Pocantico Declaration in Apr il 2008
in an attempt to develop common ground and a set of principles. Unfortunately, the declaration is full of
vague statements and platitudes, and no consensus on specific issues. In fact, it indicates explicit dissent
when it states, <cWe also recognize that we hold diverse views about the appropriate levels and usage of
profit."17

There has been much discussion about the microcredit industry regulating itself. Alex Counts, CEO of
Grameen Foundation, proposes a third-party certification scheme in his summer 2008 Stanford Social
Innovation Review article, "Reimagining Microfinance." The major drawback is that there is no authority to
ensure compliance. Since 1993, 33 microfinance organizations have joined the MicroFinance Network
and signed a Pro-Consumer Pledge that states "members will price their services at fair rates. Their rates
will not provide excessive profits, but will be sufficient to ensure that the businesses can survive and grow
to reach more people." All that needs to be said is that Compartamos is one of the members of this
network.
On a larger scale, the American experiment with deregulation of the financial services industry has been
a failure, and the United States is now on a path toward greater government regulation. There is little
reason to believe that the microcredit industry in developing countries will succeed in self-regulating while
facing much less competition, less scrutiny, and more vulnerable consumers. In 2005, South Africa
switched from relying on the Micro Finance Regulatory Council, which used a self-regulatory approach, to
establishing the National Credit Regulator, which is a classic public sector regulator.

Another potential source of constraints is citizen activism. In developed countries, citizen activism has
succeeded even when there are no governmental regulations. Witness the recent pressure on
McDonald's to introduce healthier menu options. But activism is inadequate in most developing countries,
because so many citizens lack the resources, awareness, and traditions necessary for such
empowerment. There are few activist movements exerting pressure on MFIs to reduce or prevent
exploitation of 
 consumers. One is the popular debtors' rebellion in Nicaragua - the "No Pago"
(I Won't Pay) movement - that has spurred mass demonstrations protesting    and
demanding a legal ceiling on them.

It is doubtful that C SR is an effective constraint on firm behavior even in developed countries, let alone in
less developed countries. Institutional maturity and public supportare needed for effective action by civil
society and for self-regulation by industry. As countries develop economically, politically, and socially,
these mechanisms for constraining markets will improve. But we should not tolerate exploitation of the
poor today while we wait - probably a long time - for such changes to occur. For now, government
regulation is the best way to protect microcredit clients.

THE PATH TO REGULATION

The best place to start the regulation of the microcredit industiy is to require transparency on loan terms.
The U.S. Truth in Lending Act of 1968 requires all financial firms to disclose the annual percentage rate
(APR), using a standardized formula that takes into account the various loan terms and fees. The
European Union and the United Kingdom have similar regulation, although they use a different formula.
The key is to mandate a standard formula that facilitates comparisons across loan providers.
Implementing transparency regulation for microcredit should be fairly easy, since such regulation does
not require many government resources and is unlikely to be controversial.

Developed countries have laws regulating recovery of personal loans. In the United States, the Fair Debt
Collection Practices Act of 1978 prohibits debt collectors from using abusive, unfair, or deceptive
practices to collect personal debts. Collectors are even prohibited from repeatedly telephoning debtors.
Enforcing such laws, if they existed in developing countries, might be difficult, especially in rural areas.
But difficulty is not a good reason to avoid implementation. Governments should regulate microcredit loan
recovery practices and attempt to enforce the regulation. In addition, governments and civil society
organizations should better educate microcredit borrowers about their rights. This is clearly an uphill
battle - all the more reason to get started soon.

Today, 40 developing countries impose ceilings on  . Many developing countries
liberalized   and removed limits during the 1980s as part of financial sector reform. This was
appropriate, since there was enough competition among financial service firms catering to middle-class
and affluent people in developing countries. But the same is not true for 
 targeted at the poor.
As Yunus pointed out in 2007, "The existing regulations are designed with commercial banking in mind,
but microfinance requires a dedicated regulator and a relevant set of rules." 18 In Bangladesh in 2004,
when there were no laws limiting  , the state-backed wholesale funder of microfinance
capped the on-lending of all its clients at 24 percent annual effective . More recently in 2009,
the 
 Regulatory Agency in Bangladesh announced that MFIs must limit the   to 30
percent. A 2004 presidential decree in Bolivia also imposed   ceilings on small loans. Each
country's government needs to determine the appropriate   ceiling for 
, so that it
is  enough to cover operating costs and reasonable profits and not so low as to stifle the
development of the industiy - nor so  as to be exploitative of the poor.
Although I believe governments should be the primary force in regulating microcredit, there still is a role
for other organizations to constrain the behavior of MFIs. Industry self-regulation can be a useful
supplement to legal regulation. International donor organizations, such as the World Bank and U.S.
Agency for International Development, can put pressure on their MFI clients to reduce or prevent
exploitation of the poor and to help governments draft appropriate regulations and transfer knowledge of
best practices. Large commercial banks that are wholesale lenders to MFIs should exercise their social
responsibility and press their MFI clients to behave responsibly. And civil society organizations can play a
large role in shining the light on MFIs that behave inappropriately and in educating poor borrowers about
their rights. But none of these approaches can be sufficiently effective without government regulation.

ß 9
Notes
1 Gde Anugrah Arka, "Microcredit Lenders Urged to Improve Transparency," Reuters, July 28, 2008.
2 Sudhire ndar Sharma, "D e ath by Microcredit ," Th e Times of In dia, Sept. 16,2006.
3 Carlos Danel and Carlos Labarthe, "A Letter to Our Peers," June 2008 . Available at http://www.compartamos.com.
4 Richard Rosenberg, Adrian Gonzalez, and Sushma Narain, "The New Moneylenders: Are the Poor Being Exploited
by ) 
 2 !?" Occasional Paper 15, Washington, D.C: Consultative Group to Assist the
Poor, February 2009.
5 Nimal Fernando, "Understanding and Dealing with ) 2 ! on 
," Manila: Asian
Development Bank, May 2006.
6 "Strengthen ing Consumer Protection." Available at http://financialst ability.gov/ docs/regulatoryreform/strengthen
ing_consumer_protection.pdf.
7 Akhand Tiwari, Anvesha Khandelwal, and Minakshi Ramji, "How Do Microfinance Clients Understand Their
Loans?" Chennai, India: Centre for Micro Finance/ Institute for Financial Management and Research, October 2008.
8 Rosenberg, Gonzalez, and Narain, "The New Moneylenders: Are the Poor Being Exploited by ) 

2 !?"
9 Chuck Waterfield, "Implementing Pricing Transparency in Microfinance," MF Transparency Newsletter, 2009 .
10 Subrata Kumar Mitra, "Exploitative Microfinance Interest Rates," Asian Social Science, 5(5), May 2009: 87-93.
11 "The New Moneylenders: Are the Poor Being Exploited by ) 
 2 !?"
12 Waterfield, "Implementing Pricing Transparency in Microfinance."
13 Fernando, "Understanding and Dealing With ) 2 ! on 
."
14 Brigit Helms and Xavier Reille, "Interest Rate Ceilings and Microfinance: The Story So Far," Occasional Paper 9,
Washington, D.C: Consultative Group to Assist the Poor, September 2004.
15 "The Crushing Burden of Microcredit," France 24, April 4, 2008. Available at http://
www.france24.com/en/20080404-bangladesh-burden-microcredit-caring-grameen-bank-mohammed-yunnus.
16 Tiwari, Khandelwal, and Ramji, "How Do Microfinance Clients Understand Their Loans?"
17 The Pocantico Declaration is available at http://www.accion.org/Document.Doc?id=442.
18 Muhammad Yunus, "Lifting People Worldwide Out of Poverty," Knowledge@ Wharton, May 27, 2009.
‘
‘
Karnani, A.. "MICROFINANCE NEEDS REGULATION. " a
a


1 Jan. 2011: ABI/INFORM Global, ProQuest. Web. 22 Feb. 2011.

Bangladesh, Dec. 11 -- In 1976, Professor Muhammad Yunus introduced microcredit in Bangladesh.

Within a decade many countries replicated his programme. By the time the first Microcredit Summit was
held in Washington D.

C. in 1997, microcredit has already become a household name.

How many poor families, over the decades, are lifted out of poverty is yet to be confirmed. But it is well
recognized that microcredit serves the poor who never had access to cash money, and, at the same time
it even benefits the richest with tremendous investment opportunities.

The United Nations declared the year 2005 as "The Year of Microcredit". Microrcedit received world
recognition as an effective tool to eradicate poverty. Eventually, Professor Muhammad Yunus gained trust
and friendship of many statesmen, kings and the queens.
As hundreds of micro finance institutions (MFI) mushroomed around the world, questions were raised
about loan size, loan disbursement and repayment methods, the long term socio-political impact on
beneficiaries, accountability and transparency of MFIs, and so on. The   of  charged on
micro loans is the most criticized and debated issue all along. The fact is, a whole lot
of 
 borrowers suffer from the exorbitant  of .

In 2006, the Norwegian Nobel Committee crowned Professor Muhammad Yunus and Grameen Bank with
the Nobel Peace Prize. It was in recognition of his fight against poverty, not a declaration that he sent
poverty to the museum.

And with Nobel Peace Prize, Grameen Bank and Professor Muhammad Yunus again came under fierce
attack for their performance in lifting poor families out of poverty. No one, however, accused him of
malpractice.

But Norway's national TV NRK has done exactly that very recently. NRK aired a documentary on
November 30 which claims that the Nobel laureate diverted about $100 million aid money for the poor
borrowers of Grameen Bank to another of his company back in 1996. An online newspaper headline
says, "Yunus 'siphoned Tk 7.0bn aid for poor'".

"I got most of the documents from the archives of Norad, the Norwegian aid agency in Oslo," the
documentary maker said. Documents surfaced on internet and print media suggest that the fund diverted
by Grameen was no secret. The fund, in fact, came from Germany, Norway, Sweden, and the
Netherlands. And donors knew the transfer was made to Grameen Kalyan, a sister concern of Grameen
Bank.

Since NRK aired the controversial documentary, a wave of comments, both for and against Grameen
Bank, stormed the media. While the finance minister in Bangladesh said, "No fault if there was
understanding," but Prime minister Sheikh Hasina, warned Yunus of consequences if he were found
guilty. The Nobel Laureate welcomed a probe.

One BBC report reads: "Norway says it is examining reports that Nobel Peace Laureate Muhammad
Yunus allegedly diverted millions of dollars of aid money from a bank." It adds: "International
Development Minister Erik Solheim said that it was 'totally unacceptable that aid is used for other
purposes than intended'."

Media reports, however, mention nothing about the three other countries involved; Germany, Sweden and
the Netherlands.

It appears that the Norwegians are staging a drama they have written over more than a decade.
Whichever pattern they follow to play next episodes, we guess, the show is going to end in a funny way.

One good thing is that the controversy provides us an opportunity to have a better insight into Grameen.
We hope the government of Bangladesh will conduct a fair investigation and bring Grameen Bank and its
sister concerns under microscope. Time will tell whether Yunus is guilty or not. Meantime, we I would like
to congratulate him for defying the donors and do what he deemed best for Grameen.

After all, one of the causes that foster poverty in our world, especially the chronic one in the developing
countries, is donor's policy. Isn't it!

Published by HT Syndication with permission from The Financial Express.

For any query with respect to this article or any other content requireme
"Microcredit: Looking at the brighter side. " ü 

†  11 Dec. 2010,ABI/INFORM
Global, ProQuest. Web. 22 Feb. 2011.

u   
     
 
 
u

†, 
!
 .     
" 
/ . Bingley: 2010. Vol. 1, Iss. 2; pg. 201



The purpose of this paper is to thoroughly examine sources of mission diffusion and mission drift in the
microfinance industry and to identify consequences of and remedies to these problems. Extensive field
experience relating to individual microfinance institutions (MFIs) and industry trends provides the
grounding for a review of the trade and academic literatures in microfinance and social enterprise
management. Mission diffusion arises from pursuing diverse approaches to poverty alleviation and
addressing disparate and changing stakeholder interests. Mission drift arises from commercialization and
conversion activities aimed toward enhancing ratings and achieving scale. Mission clarity can be regained
through clarification of the mission along with more effective corporate governance and performance
management systems. The tension between financial and social performance is not merely ideological -
economic realities make it almost impossible to stay on mission. Understanding these realities can help
MFIs maintain and regain clarity of mission. The paper sheds new light on reasons the microfinance
industry has not been able to deliver on promises of poverty alleviation during a period of heavy demand
rapid scaling.

 
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Edited by Jesse Dillard and Madeleine E. Pullman

2


Microfinance institutions (MFIs) provide financial services to poor clients who are otherwise excluded from
formal financial systems. The majority of microfinance firms concentrate on providing credit to
microentrepreneurs who need financial capital to fund business investment and fuel economic growth.
Traditionally, MFIs have operated as non-governmental organizations (NGOs), receiving funding from a
broad variety of sources that include philanthropy and government grants along with client fees. Like
other social enterprises, dependence on funding can push MFIs to become more innovative and
entrepreneurial ([49] Mort 

, 2003), or it can make them behave more like market-driven corporations
([29] Eikenberry and Kluver, 2004). As the microfinance industry matures, funders are becoming more
demanding in their expectations for effective investment of these funds and for clear demonstrations of
social impact. Such institutional changes have pushed nonprofits toward a corporate approach ([11]
Bruck, 2006).

Through their commercialization efforts, organizations can change in ways that compromise their
missions ([27] Dolnicar 

, 2008). Regardless of their structure, social enterprises position themselves
philosophically along a spectrum between philanthropic and commercial paradigms ([65] Dees, 1996).
Where the philanthropic model is built upon values such as stewardship and stakeholder participation, the
corporate model emphasizes strategic positioning and risk taking ([29] Eikenberry and Kluver, 2004). As
the number of MFIs increases rapidly, demand for funding intensifies. Such demand can result in intense
competition among organizations ([22] Dees, 1998; [53] Parker, 1998), as has occurred in recent years in
the microfinance industry. In response, MFIs have developed professional staff or departments to
manage the rigors of interacting with funding agencies, preparing funding applications, and managing the
accounting and reporting requirements associated with the funds.

The combination of greater demands from funders and more competition for funds often results in
fragmentation of the mission, as MFIs broaden their reach to increase funding eligibility. Like other donor-
dependent enterprises, most MFIs find it challenging to maintain commitment to the original mission when
that means forgoing critically important funding opportunities. Through this fund-seeking process, the
mission can be diffused, as the MFI attempts to satisfy a diverse range of expectations and commitments.

Availability of traditional donations and grants is tightly limited, and the demand for microfinance services
is huge - current estimates suggest that MFIs currently satisfy only about 10 per cent of the existing
market demand ([26] Dieckmann, 2007). Many microfinance organizations therefore seek to scale up
rapidly to better address the vast need for their services. Concurrently, there have been rapid increases in
funding opportunities in the microfinance space. But these opportunities are currently only available to
large, well-established MFIs that can demonstrate high levels of professionalism and fiduciary
competence similar to those required of the commercial financial sector.

The ability to grow need not be limited by access to donations and grants. For large, commercially
oriented MFIs operating in stable countries, the "floodgates" have opened, and the availability of funds
has increased radically in the past ten years, as funders with a "private sector ethos" have rapidly entered
the microfinance space ([41] Latortue 

, 2006).

Funding for these MFIs increasingly comes in the form of loans from both donors and investors - an
estimated 63 per cent in 2008 (Consultative Group to Assist the Poor ([14] CGAP, 2008)). The loans have
structures similar to commercial loans, although they may have lower-than-market interest rates. The
investment capital available to MFIs has also grown tremendously in recent years, and was estimated to
be more than $10 billion at the end of 2008 ([66] CGAP, 2009).

[56] Reille and Forster (2008) provide a comprehensive overview of the types of foreign capital
investment currently used in the microfinance industry. They report that in the past, investment capital
came primarily from development finance institutions, the private investment arms of governmental
development institutions. Currently, the trend is shifting toward private investment funds; it is estimated
that there are more than 40 of these existing funds. These microfinance investment vehicles are
increasingly available to second-tier MFIs that were previously donor dependent. As the market matures,
options like structured finance arrangements in which loan assets are repackaged as securities are also
being developed. While the bulk of these current investment vehicles have a social responsibility
component to their missions, mainstream investors are also seeking returns from microfinance
investments ([56] Reille and Forster, 2008).

Accessing available funding requires MFIs to become more professional in their governance and
operations, and function more like commercial financial institutions ([3] Arena, 2008). As a result, there is
a rapid movement in the industry known as the "commercialization of microfinance". Through
commercialization, many MFIs have changed from charities to profit-seeking businesses, and a growing
number are converting from NGO status to regulated commercial financial institutions. A few, such as the
now-famous Comportamos, have even become publicly owned corporations through initial public
offerings. Comportamos evolved from a small NGO to a public company with market capitalization of over
$1 billion. Although the company has been heavily criticized for making "too much" profit while charging
high interest rates to the poor, profitable microfinance organizations have been highly sought after by
venture capital firms and private equity groups.
While professional management and commercialization can vastly increase funding available for MFIs,
they can place great stress on the MFI's original mission. And the consequences that result when a
microfinance organization loses clarity of mission can be dire. Diffusion can result in such problems as
ineffective delivery of services, and financial distress or failure of the MFI. Drift can result in such actions
as cutting services, increasing interest rates, or shifting attention away from the poor toward wealthier
clients. Thus, as funding and commercialization pressures intensify, firms must take reasoned actions to
retain and sharpen focus on poverty alleviation.

This paper identifies and discusses a number of industry and firm-level factors that can lead to mission
diffusion and drift in the microfinance industry. The paper concludes with a brief discussion of the
consequences of shifting away from mission, and steps MFIs can take to retain focus on effectives in
alleviation of poverty.



The microfinance industry provides financial services in small denominations to the poor. These services
include lending, savings, insurance, and remittances designed for poor clients that do not have access to
financial services from mainstream financial institutions. Microfinance is thought to be one to the most
promising tools for economic development and alleviation of global poverty ([4] Armendariz de Aghion
and Morduch, 2000) and empirical evidence suggests that microfinance can have a significant impact on
poverty reduction ([12] Burgess and Pande, 2005; [40] Khandker, 2003). Other impacts of microfinance
include a broad range-related social benefits such as female empowerment and vulnerability reduction
([33] Goetz and Sengupta, 1996; [16] Cohen and Sebstad, 2000), food security ([64] Zeller 

, 1997),
in addition to business impacts such as improvements in productivity, technology and employment ([37]
Hulme and Mosley, 1996) and profitability ([39] Karlan and Vladivia, 2006).

Since it is possible for MFIs to operate in a financially sustainable manner, they possess the ability to
provide these benefits on a long-term basis without ongoing need for donor support. Microfinance
therefore offers a market-based mechanism for supporting economic growth in regions where it is
employed.

The most common form of microfinance is microcredit - small loans used by microentrepreneurs to start
or expand small businesses. Through its direct impact on business growth, microcredit currently has the
greatest potential impact on economic growth and poverty alleviation. MFIs typically offer two basic types
of business loans: individual loans and group loans. Individual loans normally range from $1,000 to 5,000.
These loans are often granted to individuals who have evidence of strong business performance, and
often require collateral. Repayment period for these loans generally ranges from six months to two years.

Group loans are much smaller, and are designed for very poor clients newly entering economic and
financial systems. The typical size of these loans is from $100 to 1,000 per group member, and the
repayment period is typically four to six months. These loans are generally awarded to groups of five to
50 clients, who co-guarantee each others' loans. Group guarantees have been very effective mechanisms
for screening clients and enforcing payment; repayment rates on these loans are generally 95 per cent or
higher. Both kinds of loans may also require clients to maintain a mandatory saving account with a
balance of 10-15 per cent of the loan amount to provide further security for the loan.

Both individual and group loans are designed to alleviate poverty by allowing poor clients opportunities for
self-employment projects that allow them to generate income and build wealth. The resulting financial
capital provides the means for clients to better provide for household food, shelter, healthcare, and
educational needs. It can also help clients smooth consumption and more effectively deal with economic
shocks.

Although the microfinance industry is united in its mission of poverty alleviation, MFIs can be divided into
two camps based on the strategy they pursue to achieve this mission: the "welfare" camp and the
"institutionist" camp ([67] Morduch, 1998). Those in the welfare camp tent to focus directly on poverty
alleviation, often serving the poorest of the economically active poor - those living below 50 per cent of
the poverty line. In addition to financial services, these MFIs may offer or link clients to other private or
governmental poverty-related services, such as literacy or AIDS training.

MFIs in the institutionist camp tend to focus on outreach, serving as many poor clients as possible
through high-quality financial services alone. They believe this can best be accomplished by institutions
that are financially self-sufficient and can grow without continuous injection of donor funding ([62] Woller
and Dunford, 1999). Although their approaches may differ, both camps ultimately seek to help the poor
build their businesses, accumulate productive assets, and stabilize consumption.

# 



Increasingly, MFIs find it difficult to mange the growing tension between maintaining focus on poverty
alleviation and accommodating the demands of funders and markets. We divide our discussion along the
lines of two basic problems: mission diffusion, which occurs when organizations in the industry attempt to
accomplish multiple objectives that may be incompatible with the primary mission, and mission drift, which
occurs when organizations drift away from their focus on poverty towards achievement of financial goals.




When MFIs pursue multiple, competing objectives, they often find that their focus on mission is diffused.
While the industry is ostensibly focused on poverty alleviation through financial services, the actual
activities of microfinance organizations often extend far beyond traditional services offered by the other
organizations in the financial services sector. These services can include training, value chain support,
and access to social services such as healthcare, housing, and literacy programs. MFIs also commonly
engage in advocacy, working to improve regulatory regimes on behalf of their clients, who lack public
voice ([58] Sievers and Vandenberg, 2007).

Taking a multifaceted approach toward a complex social issue is not a problem on its own. Diffusion only
becomes problematic when the MFI lacks a comprehensive system for effectively managing a set of
diverse activities. When an organization expands beyond its original mission intentionally, and develops
proper processes for managing the expansion, it can be considered to have effectively broadened its
mission. For the purposes of this paper, we use the term diffusion to refer to activities that are not well
integrated into the overall strategy of the MFI or have unintentionally shifted resources and managerial
attention away from priority objectives.

The most common non-financial service provided by MFIs is training. Most MFIs provide some training to
their clients before granting loans or providing other services. Since many borrowers are first-time
borrowers and unfamiliar with practices necessary to manage credit, MFIs offer orientation or
sensitization meetings designed to make clients aware of which microfinance services are available in the
region, and how these services might be beneficial to microentrepreneurs and other clients that interact
with the service offerings of the MFI. In addition, they typically offer training in the use and management
of credit - including topics such as the importance of selecting a payment and loan size that meets within
the client's cash flow capacity, and the importance of carefully managing funds, through activities such as
setting aside cash on a daily basis, so that the loan can be repaid on time ([58] Sievers and Vandenberg,
2007).

In general, these training activities directly support achievement of the mission. They tend to serve
marketing purposes such as increasing product awareness, enhancing repayment of microloans, and
protecting the lender from default. Many MFIs, however, go well beyond basic training, pursuing a holistic
strategy based on market subsectors, or "value chains". The value chain approach, supported by
Department For International Development, Swedish International Development Cooperation Agency,
and others, involves identifying trade barriers within an industry and helps companies overcome them.
MFIs seeking to develop the value chain engage in activities such as researching markets, identifying
how rents accrue through the value chain, and designing interventions such as information sharing or the
development of trade associations ([47] Mitchell 

, 2009).

Both socially and commercially oriented MFIs engage in these training activities. However, for a variety of
reasons discussed below, many MFIs engage in activities that extend far beyond the original scope
outlined in their missions, which can lead to diffusion. The first, and most important of these, is the nature
of the problem these social enterprises seek to address.

, :    

The basic financial training described above tends to directly support achievement of MFI objectives, as it
improves clients' abilities to use financial services in a manner that enhances their income level or
stability and thereby directly impacts poverty. Poverty, however, is a complex, multifaceted problem, and
the immediate needs of impoverished clients often extend far beyond the reach of financial services ([1]
Ahmed and Rafi, 1999). Clients commonly lack access to clean water, adequate nutrition, safe shelter, or
basic education. Such problems impede their ability to effectively manage their businesses and render
the financial capital and other services they receive ineffective. For example, it is estimated that health
problems are among the primary causes for microbusiness interruption and failure ([4] Armendariz de
Aghion and Morduch, 2000). Thus, MFIs dedicated to helping the poor often seek out means to improve
client health, such as through nutrition or HIV/AIDS education, or by securing client discounts to clinical
services or health insurance.

Defaulting on loans commonly occurs during periods of family illness, when clients redirect business
funds toward personal use ([10] Brett, 2006). Thus, programs to improve health can have direct impact on
the financial success of the client, and support poverty alleviation. However, the knowledge and expertise
required to manage these programs and services are often well beyond the capabilities of MFI
management and staff. Some MFIs address needs like healthcare by developing in-house expertise,
structures, and processes that allow them to provide these services on their own. Others provide clients
access to these services by forming partnerships with NGOs or governmental organizations that work
directly in these areas and already possess the necessary expertise ([58] Sievers and Vandenberg,
2007). Although the latter route is less resource-intensive for the MFI, it nonetheless must engage staff
and other resources in planning and managing these partnerships. If not carefully managed and well
integrated with other activities, healthcare initiatives can draw resources and attention away from the
primary mission of providing impact through financial services rather than promoting that mission.

Nonetheless, needs of the impoverished are so great, and the promise of poverty alleviation so strong
that many MFIs find themselves adding more and more services until microfinance represents only one of
the many services offered to the poor. Some organizations have been successful in pursuing a multi-
faceted poverty-alleviation strategy. Bangladesh Rural Advancement Committee (BRAC) in Bangladesh,
for example, has been exceptionally successful in addressing needs of the poor through services as
diverse as supporting human rights, providing legal services, marketing seeds, running fish hatcheries,
and delivering health interventions ([38] Jonker, 2009). Managing such a range of activities, however,
requires a broad variety of skills and expertise that extend far beyond the capabilities of most MFIs.

Even with the requisite capabilities, BRAC has experienced failures in some of its social enterprise
efforts. Its attempt to enter the irrigation pump businesses by providing financing to pump salespersons
failed when weather and food prices beyond the organization's control made operations unprofitable. Its
founder argues that gaining an adequate understanding of social needs and enterprise opportunities in an
area requires many years of direct experience ([38] Jonker, 2009).

, 
At the same time, microfinance organizations struggle with competing facets of the poverty problem, they
also suffer from competing beliefs and interests among stakeholders about the best way to address the
problem. Relative to stakeholders of mainstream financial institutions, microfinance stakeholders are likely
to hold strong and divergent beliefs about the appropriate direction for the MFI. These stakeholders,
which include board members, funders, and employees are often drawn to the industry by their belief in
the mission and desire to alleviate poverty. Board members, employees, and investors often accept lower
compensation for their efforts because they have a strong belief in the social value their work can
contribute.

MFIs often have difficulty making trade-offs among the competing priorities of these stakeholders,
because a broad range of priorities can be viewed as having the potential to positively impact the clients
and are therefore worthy of pursuit. And in the social sector, there is often competition for board
members, so new members are readily added to the board based on funding prospects rather than
agreement with the stated direction of the organization.

Board members are often ineffective at managing executives in a coherent and clear manner, and even
among the top executive team, priorities and desired organizational direction may be at odds. In addition,
they often lack experience in the industry, and fail to understand the relationship between alternative
courses of action and the mission they need to pursue. And board meetings are often dominated by
discussions relating to fundraising efforts and budgeting, with insufficient attention toward strategy-
making or evaluating program effectiveness.

The need to continually attract new sources of funding can also lead to fragmentation of focus. The most
accessible funding is often restricted to specific initiatives or programs. When the MFI seeks funding
through such opportunities, it often finds itself under increased financial pressure that detracts from
achievement of the initial mission. This happens because the funding opportunities often cover the
marginal costs of accomplishing the objectives, but fail to contribute significantly toward coverage of the
overhead or toward coverage of the resources necessary to develop new processes to accommodate the
initiatives' demands. Thus, when they shift human and other resources away from mainstream programs,
they might weaken the organization's ability to support those programs.

, 2

The vast majority of microfinance organizations are small NGOs that are not currently operating in a
financially sustainable manner. These organizations are fragile financially, and are reliant on donor
funding and grants to stay afloat. Funding levels and stability are rarely linked closely with the MFIs social
or financial performance. Rather, they are influenced by a broad range of economic, social, and personal
factors that are often beyond the control of the MFI.

When funding falls below expectations, MFIs may scramble to make up the differences by creatively
broadening the web for seeking sources of funding. These new funding sources may solve immediate
financial crises, but may come with requirements and objectives that pull the MFI in many directions that
fall beyond the traditional range of activities historically supported by the mission.

Access to many funding opportunities in microfinance is intensely competitive. For MFIs that are heavily
reliant on external funding, donors and funding agencies wield tremendous power and influence on MFIs.
And funders typically seek to impose their own priorities that may not be fully consistent with those of the
MFI, leaving the MFI in a position of shifting away from its original mission, or splitting its focus in an
attempt to address multiple priorities ([32] Frank 

, 2008).

The problem is exacerbated by the fact that MFIs are often dramatically underfunded and
underdeveloped in terms of basic infrastructure. Heavy investment in systems and structures tends to
stabilize the direction and processes of these organizations. Lacking that investment, the organization
lacks the anchors that keep it heading in any particular long-term direction, and it can be subject to short-
term changes based on temporary influences.

There are a number of basic causes for this lack of long-term investment and direction among MFIs. One
is the short-term nature of the funding itself. Many funding agreements for financial service delivery last
for a single year or less. They create a situation that requires MFIs to deliver immediate results, and at the
same time, remain continually engaged in the fundraising process. Compounding the problem is the fact
that funders generally seek to fund programs - they want their investments to go toward achieving
something unique and new that directly and rapidly impacts the clients and the problems they seek to
address ([6] Bland, 2009). Investing in a new performance measurement system, or in back office staff
that can develop clear polices and standards, is far less appealing. When the funding is from the capital
markets, demands for near market levels of interest require that the investment is used directly and
immediately for lending and similar activities that can generate significant and predictable financial
returns.

#  

Both investors and donors in the microfinance arena are heavily interested in providing funds for
innovations in microfinance. MFIs with solid, stable, performance over time, even with exceptional
profitability and social impact, are likely to be ineligible for many available grants and funds. These
organizations are passed over by funders because they offer nothing new. Funds in the area are typically
interested in entrepreneurship and innovation, not in funding tried-and-true techniques ([31] Fosu, 2010).

These funders are looking to find and fund the "next big thing" in microfinance. MFIs seeking to secure
these lucrative and prestigious funding opportunities must shift energy away from core mission and
functions to develop, pilot, and ultimately implement new products, processes, technologies, and the like.

Industry pressures support this desire for innovation. Like organizations that fund them, MFIs themselves
gain image and prestige for new initiatives. Mainstream and industry news agencies and other media
outlets are quite naturally interested in reporting on successful new developments and ideas in the field.
And for many MFIs, media attention is a crucial component in the overall fundraising strategy.

The desire for new opportunities can encourage innovation development of new approaches and
technologies that can provide new ways to serve the poor. However, when sought by small MFIs that are
not typically entrepreneurial and lack resources and structural support for innovation, pursuit of these
projects can lead to diffusion of the mission and reduce the MFI's ability to effectively serve its core
markets.

2 

Institutional pressures are also quite strong, especially for MFIs that operate as regulated banks.
Managers face industry pressure to manage their operations and activities more like other commercial
institutions. Adopting a corporate approach can help organizations demonstrate their fiduciary fitness and
increase legitimacy ([2] Ang and Cummings, 1997; [52] Oliver, 1997). These pressures may come from
the organization's desire to copy the actions of corporate competitors or they may be a result of pressures
to maintain legitimacy in the eyes of key stakeholders, including regulators and clients, as well as funders.
Increasingly, legitimacy in the MFI industry is greatly enhanced when an MFI is viewed as behaving less
"like an NGO and more like a bank". In fact, some of this pressure comes through competitive routes, as
traditional banks such as Eco Bank and Barclay's move down market to compete in the microfinance
space in some regions.

The perceived rigor and professionalism of these institutions can be very impressive to local regulators
and politicians. Nonetheless, the same changes that might be desirable to other stakeholders may turn off
the clients the MFI seeks to serve. Poor, uneducated clients are often intimidated about entering banking
offices. And while banks such as OIBM in Malawi make a strong push to tell clients that branches will
welcome even when they are shoeless or dirty from work, the luxurious bank lobbies and suit-wearing
staff may still turn these clients away ([55] Pelakamoyo, 2007). As such changes are made, the MFI may
find itself appealing to wealthier and more sophisticated small business clients rather than the
impoverished microentrepreneurs it seeks to serve.




In recent years, mission drift has become a critical issue for MFIs, regardless of whether they operate as
NGOs or for-profit banks. The tension between the desire for social impact and the demands for financial
performance can be intense, and managers in some MFIs spend a great deal of energy working to
balance the two. A basic tension between seeking higher profits to satisfy capital markets and only
breaking even by offering low-interest rates to clients can be a very difficult challenge, even for managers
very strongly focused on a poverty-alleviation mission. These managers must thoroughly understand the
tradeoffs in such decisions and make such choices very carefully in order to effectively balance social and
financial performance.

For many managers and MFIs facing these pressures, there has been a natural tendency to shift toward
financial performance in absence of a well-defined plan for staying on mission. These organizations are
lean, and day-to-day operational and external challenges compete for attention with the constant
scramble for funding, leaving managers little opportunity to reflect on how market forces are shifting the
course of their organizations over time.

Pursuit of financial sustainability, generally defined as generating sufficient income to cover all operating
and financing expenses over time, is seen as the principal cause for mission drift in the MFI industry ([18]
Copestake, 2007). There are a variety of reasons MFIs have intensified their efforts to achieve financial
sustainability. Even the basic desire to expand programs and organizational capabilities can result in
tradeoffs that can jeopardize the organizations' social mission ([15] Cerven and Ghazanfar, 1999).
Increasing competition for both clients and funding sources among MFIs and, increasingly, commercial
banks, make it almost impossible for MFIs not to strengthen focus on financial issues.

 

Scaling up to serve more clients has been an important challenge and goal for the microfinance industry.
The [46] Microcredit Summit Campaign (2008), a large consortium of microfinance practitioners and
industry-related organizations, has a goal of serving 175 million clients by 2015, up from their previous
goal of 100 million clients, which was reached in 2007. The industry has been growing rapidly; [26]
Dieckmann (2007) reports a 26 per cent growth rate in client base during 2006. But there is still a long
way to go until all poor people have access to financial services. The World Bank estimates suggest that
there are over 2.7 billion people currently living on less than $2 per day - roughly 40 per cent of the
world's population. And although the current microfinance loan portfolio is estimated at $25 billion, that
represents only approximately 10 per cent of market demand, suggesting a huge gap between potential
demand and supply of microfinance loans.

The availability of credit and other financial services is seen as a critical factor in poverty-alleviation and
related areas including health, nutrition, education, and empowerment of women ([43] Littlefield 

,
2003). To increase impact on a global scale, the industry must grow and expand its outreach. Scaling up
to achieve impact is also pursued heavily by individual MFIs that have greater demands for loans than
their financial and human resources allows them to meet, or seek to operate in underserved markets.

MFIs also seek to grow due to the desire to achieve economies of scale, reduce the costs of serving
clients, and achieve financial sustainability. The burden of overhead associated with administrative staff
and systems can be very heavy for MFIs. And the average per-client profit for microloans is typically very
small. Scaling can allow MFIs to better spread their fixed costs, reducing the amount each loan must
cover. Lower costs can result in financial performance for the MFI and/or reduced costs for the clients.

Operating at scale can have many branding and funding benefits as well. MFIs are typically placed in
categories based on the number of clients they serve, and employees at all levels of these organizations
are rewarded for growth. Number of clients served has become synonymous with the size and market
strength of the MFI, and those with the most clients are typically most prestigious. Many governmental
and institutional funding and investing agencies are designed to deal most effectively with larger sums of
money that cannot be absorbed by most small MFIs. Scaling up may provide small MFIs with greater
credibility and access to local and international funding opportunities.

At least, one investing organization invests with an expressed goal of accelerating microfinance growth.
Unitus, Inc. seeks out high-quality MFIs with innovative products focusing on increasing scale for high-
quality, high-potential MFIs. Unitus, Inc. seeks to help its clients to rapidly grow to ten times their starting
size by providing capital and consulting support. Achieving financial sustainability is considered to be a
fundamental necessity for MFIs seeking to achieve rapid growth and scale ([19] Christen and Drake,
2002). Strategies for achieving scale are not universal. Some approaches are spontaneous, while others
are deliberate and can involve changes in the size of a program, the number of programs and services
offered, or in the level of influence pursued ([28] Edwards and Hulme, 1992; [68] Uvin and Miller, 1994).
Regardless of the strategy chosen, rapid scaling can cause the MFI can lose site of its poverty-alleviation
mission, and there is currently no reliable indicator of mission drift that could allow MFIs to recognize a
shift away from mission when it occurs ([35] Hishigsuren, 2008).

, 1

There is a growing belief in the industry that microfinance must use market logic and harness commercial
forces to develop cost-effective models for bringing financial services to the poor. Thus, there is
tremendous pressure on MFIs throughout the industry to seek commercialization.

In its simplest form, commercialization represents the adoption of market-based practices by MFIs.
Commercialization is viewed as critical for MFIs seeking to achieve scale. The underlying logic is that
when MFIs become more efficient in the management of costs and profitability, they can maximize their
ability to translate available sources of funds into increases in outreach to poor clients.

Pursuing a business-oriented approach to microfinance can lead MFIs to develop new products that
appeal to new market segments and to increase the quality of service in order to attract and retain new
clients. These outcomes can provide dual benefits in support of social and financial objectives.

However, the vast majority of MFIs consistently operate at a loss, and it has been argued that effectively
serving the poor may require lower-than-market interest rates ([48] Morduch, 2000) or concessionary
financing arrangements. This calls into question the validity of the logic underlying commercialization and
its ability to eliminate the industry's reliance on donor funding. Nonetheless, a number of MFIs have
recently reported achievement of financial sustainability, leading the industry and its stakeholders to
believe that it is both possible and responsible for the industry to pursue sustainability.

,   

  ;! 2<

Current logic in the microfinance industry suggests that the most reliable route to commercialize and
reach scale is through conversion from an NGO to an RFI. Conversion to commercial banking began with
BancoSol in 1992, and has spread rapidly in the past two decades. Recently, it is estimated that at least
48 MFIs are currently operating as regulated banks. In addition to NGOs that convert, commercial
institutions can enter the microfinance space, or new commercial microfinance organizations can be
started.
Conversion offers a variety of advantages to both the MFI and its clients. Most importantly for pursuit of
the mission, conversion to an RFI allows the MFI to offer savings services to its clients. Accepting savings
requires a high level of fiduciary competence and is therefore limited to regulated institutions in most
countries.

Savings services can be enormously beneficial to the poor, who typically lack any secure mechanism for
amassing wealth, or even the small lump sums needed to pay for a school fee or doctor visit. Thus,
savings capacity can greatly contribute to the financial well-being of the poor client. For the MFI, access
to savings is often viewed as a stable and inexpensive means for securing funds for on-lending; MFIs that
offer savings often report that savers exceed borrowers by a multiple of 5 to 1.

Conversion brings with it the requirement for a strong system of internal control, transparency in reporting,
and oversight by experienced regulatory agencies. These features provide confidence to and reduce
monitoring costs for creditors, and can greatly enhance an MFIs ability to secure funds from commercial
credit markets, often at rates far lower than those offered to unregulated institutions ([30] Fernando,
2004).

Of course, conversion is no panacea, and may decrease the profitability of the MFI, as the MFI incurs
costs to comply with demands of functioning as a regulated bank. MFIs are often required to hire
professional staff with banking experience and add bankers to their boards and secure attorneys and
accountants familiar with regulatory issues. They must develop new operational and control procedures
and invest in training for staff. In addition, converting MFIs regularly need to upgrade their information
technology to ensure real-time access to current savings balances and their infrastructure, to improve
their retail presence and ensure security for tellers and stored cash. Finally, they must develop a high
level of fiscal rigor and discipline, especially when they offer savings, to ensure that tiny accounts for
impoverished clients can be leveraged to generate revenues that outweigh their costs ([63] Woller, 2002).

In addition to these costs, the MFI must devote significant managerial attention to the new administrative
demands that come with managing the transformation and pursuing the new profitability demands of both
regulators and creditors. In the process, it is easy to drift away from attending to social impact objectives,
at least for the years immediately surrounding the transformation process ([57] Schmidt, 2010).

! 

As the microfinance industry has matured, a variety of methodologies has arisen for rating the quality of
individual institutions. The purpose of these rating systems is to provide common performance standards
that allow firms and funders to benchmark and evaluate quality and efficiency of MFIs. Effective ratings
systems can provide confidence to local regulators and global financial markets. In some respects, these
ratings have achieved some of these objectives, by encouraging microfinance industries to become more
transparent to their own stakeholders and to share information with the industry to allow for
benchmarking, comparisons, and to drive performance improvements.

The problem with the existing rating systems is that they are heavily weighted toward financial
performance and either ignore the social impact of the MFI or provide only superficial indicators of
effectiveness in this area. The CAMEL instrument, developed by ACCION (www.accion.org) using a
methodology originally developed for commercial lenders in the USA, has been widely used by ACCION
and other large players in the MFI industry. The instrument evaluates financial and managerial
performance in five areas: capital adequacy, asset quality, management, earnings, and liquidity. The
performance review is based largely on the firm's audited financial statements, and essentially rewards
those MFIs that function most like commercial banks.

Other systems provide similar assessments. MicroRate (www.microrate.com) identifies fiduciary and
credit risk that is designed to help MFIs link to domestic and international capital markets. MicroRate is
also focused on operations and financial performance, assessing management and governance,
management information systems, financial conditions, credit operations, and portfolio analysis.

The Girafe rating developed by PlaNet finance (www.planetrating.com) also provides a rating system
geared toward investment risk, and gives the highest ratings to institutions that have achieved financial
self-sufficiency. Unlike others, this rating also includes a factor for evaluating MFIs on the basis of their
impact on economic development. This factor includes measures such as increases in customer incomes,
number of business and jobs created, and personal development. Social impact-focused rating systems
are rare, however, and the CGAP, the leading information provider for the microfinance industry, now has
a task force charged with promoting social performance assessment through common definitions and
reporting standards ([13] CGAP, 2007).

The Microfinance Information Exchange, Inc. (MIX), is an industry organization jointly funded by CGAP
and other large foundations that support the microfinance industry (www.themix.org). MIX is an industry
alternative to private rating systems and provides business information and benchmarking services to the
industry. It collects self-reported data from industry participants, adjusts the information for comparability,
and presents the information in summarized form through a web-based vehicle that allows for comparison
across geographic regions, scale, and target market. In addition to a large number of standard measures
of profitability, growth, and portfolio risk, MIX collects a small number of social indicators, including
average loan size and percent of female borrowers. These ratings are highly visible, and used by other
organizations to rank MFIs. Forbes used information from MIX to develop a list of the top 50 MFIs. Like
other ratings, the list ignored social impact and evaluated institutions based on scale, efficiency, risk, and
returns.

Rating systems for charitable organizations also emphasize efficiency and financial performance while
remaining silent on issues of social impact. Systems such as the well-known Charity Navigator
(www.charitynavigator.org) rate organizations based on how much they spend on fundraising and
administration in proportion to total expenses in addition to profitability, growth, and liquidity. Such
systems are heavily used by donors and other stakeholders, and can create pressure for managers to
make decisions that promote financial performance at the expense of social performance. Birchard
suggests that these measures make it difficult for donors to see beyond fiscal efficiency, and therefore an
insufficient basis for effective allocation of donor funds ([5] Birchard, 2005).

, 
 



Each of these sources of diffusion and drift has the potential of weakening focus on the organization's
original mission, as it seeks to expand products, services, or markets, or to adopt new business models,
processes, or technologies. As the organization adds activities not strongly aligned with the primary
focus, employees and other stakeholders can experience confusion about the institution's objectives and
priorities, and may be pulled in conflicting directions by various opportunities, or pushed by various
stakeholders. The resulting fragmentation of time, energy, and other resources can lead to internal
conflict within the organization, as organizational units pursue different objectives, or to conflicts with
external stakeholders as the organization fails to live up to old commitments and expectations as a result
of chasing new opportunities.

As an MFI inevitably drops or de-emphasizes existing programs or clients to pursue new ones, it can
inadvertently create a negative social impact for part of the client base it seeks to serve. In addition, it can
experience a loss of reputation and trust from these clients as well as from other stakeholders and
partners.

Drifting too far toward financial objectives and away from social ones can create the potential for more
problematic consequences. In a massive rush to reach scale and profitability, the MFI commonly push for
reduce costs by increasing their loan officer to client ratios. It is not uncommon today to find MFIs with
ratios of 500 or even 1,000 clients per loan officer.
Although such outcomes have been applauded by proponents of financial sustainability, they can leave
loan officers with less time to effectively screen clients or assess cash flows to determine affordable loan
size. Since group lending clients bear the burden of monitoring and the costs of default, this can
significantly increase their risks. Clients overburdened with debt they cannot repay face financial ruin.
Furthermore, group members will also bear the costs of the default, and as a consequence, suffer
financially. But financial damage is only part of the problem. Social ties between group members can be
strained, and the social fabric of the communities can be damaged ([44] Marr, 2004).

MFIs may experience "contextual" mission drift, in which their increased emphasis on the technical
aspects of lending obscures their attendance to the socio-cultural impacts of the loans. Extending loans in
a manner that is insensitive to the cultural context can lead to problems such as increased workload, as
women seek to simultaneously manage their enterprises and households, and even increased domestic
violence as financial empowerment challenges family stability ([25] Deshmukh-Ranadive, 2008).

Perhaps, the most common tendency among MFIs seeking higher profitability is to shift up the poverty
pyramid toward wealthier clients. This causes them to drift away from the mission known as "depth of
outreach" - serving the poorest of the economically active poor, a move that can also affect the gender
distribution of the loan portfolio ([50] Navajas 

, 2000). The smallest loans carry administrative costs
similar to larger loans, and may be perceived as riskier for the MFI. By shifting to larger loan sizes, the
MFI can maintain portfolio size and growth rates while reducing transaction costs. This can leave the
poorest clients without access to financial services. Research confirms conventional logic that MFIs must
make a trade-off between depth of outreach and financial sustainability ([51] Olivares-Polanco, 2005),
although through increased efficiency and risk management, most MFIs have been able to maintain
average loan size ([45] Mersland and Oystein Strom, 2010).

Profit-seeking MFIs similarly tend to shift toward serving clients in urban areas, where population density
and sufficient infrastructure makes them easier and cheaper to serve than rural clients. Many urban areas
are already well served by MFIs, and others are considered to be saturated. Thus, by targeting their
efforts in these areas, MFIs may simply be taking existing clients away from other MFIs rather than
providing increased outreach to underserved clients.

Another prevalent problem is increasing interest rates accompanied by provision of untrue or misleading
information about clients. Sustainable MFIs must charge sufficient interest to cover all direct, overhead,
and financing costs. This can lead to interest rates that are very high, often as high as 100 per cent APR
or more. Yet, MFIs typically advertise interest based on monthly rates of 2-4 per cent. This can provide a
very misleading impression to impoverished clients who lack the capacity to calculate the effective
interest rate.

Even for sophisticated financial analysts, interest rates can be difficult to calculate. MFIs commonly
require that clients leave a portion - generally 10-15 per cent - of the balance borrowed in a savings
account to help collateralize the loan. This account may be interest bearing, but it is also part of the loan
and included in the interest calculation. Further, interest on the loan is often calculated based on initial,
rather than declining balance. Clients also pay loan origination and re-origination fees and late fees,
which are not calculated in the interest rate. And they maybe required to purchase small insurance
policies that cover the debt in the event of illness or death of the proprietor. In countries with usury laws,
some MFIs charge low-interest rates, but add on additional fees that can be quite high and continue
through the life of the loan.

Another widespread consequence of commercialization is the reduction or elimination of supplementary

services to microfinance clients, such as business development services. While some clients are
microentrepreneurs by choice, many own business out of necessity, because other sources of income are
unavailable. These clients may lack the capacity to effectively invest and manage additional financial
capital ([20] Datar 

, 2008), and empirical evidence has shown that business training can be effective
in increasing sales and enhancing the capacity for repayment ([39] Karlan and Vladivia, 2006).
When clients do not have the financial literacy required to understand the cash flow implications of their
credit decisions, they can easily be encouraged by MFIs seeking ever-larger portfolios, into loans that
they cannot effectively manage. As a result, clients can take sequential loans with very little progress out
of poverty, or they can be overburdened by debt. Grameen Bank, which pioneered many of the credit-
granting methodologies most widely used today, has experienced significant repayment difficulties; in
some regions up to 32 per cent of clients are in arrears ([54] Pearl and Phillips, 2002). And there is an
increasing evidence that too many clients are taking multiple simultaneous loans to manage their cash
flow and repayment needs ([69] Kamath 

, 2008, [60] Srinivasan, 2010).




To both recognize the pressures leading to diffusion and drift, and to help avoid potential adverse
consequences of shifting away from the mission, the MFI can employ a variety of standard management
control practices. These practices, which are commonly used in both for-profit and not-for-profit
enterprises, can serve as tools to help MFIs maintain and regain focus on the organizational mission.
Among the most potentially useful in this context are: mission clarity, performance measurement, and
effective governance.

To avoid drift, the MFI must first develop and communicate a very clear mission. For many NGOs, the
organizational mission and the strategies for achieving it are never fully specified. Thus, clarification of the
mission can be an essential first step in anchoring the organization's focus on its desired social impacts.
For MFIs as for nonprofits in general, this means shifting focus from counting the number of clients served
toward maximization of social impact ([42] Letts 

, 1998). To develop meaningful strategies for
achieving the mission, many nonprofits develop a "theory of change" that details how resources will be
invested and specifies the processes that will be implemented to convert resources to social impact ([17]
Colby 

, 2004)). In microfinance, such clarity is critical not only for guiding resource allocation and
operational decisions, but also to guide the MFI toward pursuing mission-appropriate funding.

With a clear mission and well-defined theory of change, an organization can determine which results to
hold itself accountable for ([9] Bradach 

, 2008). Performance measurement systems can then be
implemented to both monitor social impact and guide organizational action. High-performance MFIs
seeking to maximize impact make a critical error when they use growth and expansion as indicators of
social performance. These organizations must more directly measure impact on poverty status of their
clients, and impact on intermediate variables affecting poverty.

The industry as a whole has lacked systematic efforts to measure poverty, despite the stated importance
of poverty alleviation. Measuring poverty is difficult, and now the Microcredit Summit Campaign's
"Movement Above $1 a day Threshhold Project" provides tools that can help MFIs determine whether
their clients are moving up the poverty scale (www.microcreditsummit.org). The Mix Marketplace
(www.mixmarket.org), an industry organization that collects and disseminates performance metrics, has
recently begun to collect social performance measures, including measures relating to poverty status.
Although only a small portion of the participating MFIs currently report these data, the framework of
suggested metrics provides a useful starting point for MFIs seeking to monitor impact on the poverty-
alleviation mission.

[20] Datar 

(2008) hold that measuring the impact of the loan on the client's business income is also
essential. They argue that in order to claim to produce poverty-alleviation benefits, the MFI must assess
its impact on client business factors, such as business value, total income, or income variability, because
the poverty impacts of microfinance result directly from improvements in business performance.
Addressing intermediate impacts, such as business assets and income, can be useful in more directly
tracing the relationship between organizational activities and poverty alleviation. A number of methods
are available for measuring or estimating business performance in this context ([24] de Mel 

, 2007).
Effective governance at the board level is also important in maintaining a focus on the organizational
mission. Among nonprofits, the mission rarely draws sufficient attention from board members, who have a
variety of competing objectives and may not view the organization as a mission-driven business ([61]
Weisman, 2003). And because nonprofits lack the feedback and discipline imposed by the market, the
board must ensure that the organization remains effectiveness and efficiency in pursuit of organizational
goals ([34] Herzlinger, 1994).

Strong governance is particularly important for organizations undergoing rapid scaling, as is the case with
many MFIs. [7] Bloom and Chatterji (2009) argue growth in size is unlikely to be accompanied by
commensurate growth in social impact unless the organization carefully manages a variety of important
scaling levers. Organizations may need to form new networks and affiliations for gaining access to
network and technical assistance ([23] Dees 

, 2004) Such activities can be instrumental in both
scaling social impact and changing the institutional environment through mobilization of participants and
development of new institutional arrangements ([8] Bloom and Dees, 2008).

Finally, boards should play a key role in managing and monitoring the social performance of the MFI. [3]
Arena (2008) argues that to ensure that MFI boards should pursue social audits to ensure that the
organization is achieving the expected and desired social impact. In addition, he argues that the board
has a duty to monitor the actions of MFI clients to ensure that they use MFI services in a manner that
benefits them. The board should support the interests of clients by enabling mechanisms for shareholder
activism and voice.

,   

Although the microfinance industry has made dramatic strides in expanding the number of clients served
and the amount of funding available, it has not made commensurate gains in poverty alleviation. In part,
this is a result of diffusion and drift that shift focus away from clients and toward funding sources and
financial results.

Diffusion often results from efforts to address a social problem using a multi-faceted approach. In
microfinance, organizations tend to be pulled in many directions, both by the broad range of needs
expressed by impoverished clients, and by the multiple, varied interests of donor agencies, board
members, and other stakeholders. Drift in this industry typically pressures MFIs to take emphasis away
from social impact in an effort to achieve the financial self-sufficiency that enables expanded access to
capital and the ability to serve more clients.

The microfinance industry as a whole has been enormously effective in rapid scaling. The industry has
used a variety of mechanisms that have enabled this growth, including the development of industry-wide
organizations for sharing data and best practices, performing rating and consulting services, and lobbying
for pro-microfinance legislation ([21] Datar 

, 2010). But to this point, industry-level efforts have been
directed toward financial efficiency and professionalism, and have overlooked signs of mission failure,
such as high dropout rates and increasing overindebtedness among clients.

But the industry can play a role in scaling social impact as well, and is beginning to do so. The industry
has recently developed reporting standards and a platform for sharing social performance information
through the clearing house that publishes financial performance data. Similar, industry-wide organizations
can also be mobilized to share best practice information that enables MFIs to reach the vast demand from
underserved markets, provide business development services to enable vulnerable clients to use capital
to best advantage, develop products and services more aligned with the broad range of client needs, and
provide more effective screening and credit-scoring mechanisms to more effectively direct resources..

Firms in the microfinance face tremendous pressure to please financing partners and demonstrate
financial results. Careful and diligent attention to poverty alleviation is essential to avoid mission diffusion
and drift. Firm managers at all levels, board members, and members of industry-wide organizations must
take rapid and determined action to ensure that the microfinance industry meets its enormous potential
for improving the lives of the world's most vulnerable populations.

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Further Reading
1. Hsu, M.-Y. (2007), "The international funding of microfinance institutions: an overview", ADA-Microfinance
Expertise, ADA, Luxembourg, November 23.
2. Snibbe, A.C. (2006), "Drowning in data", Stanford Social Innovation Review, Vol. 4 No. 3, pp. 39-45.

ß
:9
About the authors
Marc J. Epstein is a Distinguished Research Professor of Management at the Jesse Jones School of Business at
Rice University in Houston, Texas. He has written extensively on measuring and managing social impacts in for profit
and non-profit organizations. Marc J. Epstein is the corresponding author and can be contacted at: epstein@rice.edu
Kristi Yuthas is the Swigert Professor of Information Systems at Portland State University. Her research focuses on
measuring and managing performance in MFIs and other social enterprises.

Marc J. Epstein, and Kristi Yuthas. "Mission impossible: diffusion and drift in the microfinance
industry. " a

%
 
u 



 1.2 (2010): 201. ABI/INFORM
Global, ProQuest. Web. 22 Feb. 2011.

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.
The study argues for the integration of good governance principles in developing financially viable,
effective and social equity-laden micro-credit strategy for the impoverished agrarian reform beneficiaries
in Western Mindanao. It particularly examines the program design and implementation strategies of the
Enterprise Development Credit (EDC) sub-component of the Western Mindanao Community Initiatives
Project (WMCIP). The study aims to provide lessons and insights for the planning and implementation of
comprehensive and integrated Official Development Assistance (ODA)-funded government programs for
poverty reduction and rural development.

The data and information were generated from combined descriptive and field studies covering a sample
survey, group discussions, interviews, field visits and observations, official documents and other
secondary sources. The respondents were officials and field personnel of WMCIP, line agencies, local
government units (LGUs), and non-government organizations (NGOs); officers and members of
cooperatives and people¶s organizations (POs); religious leaders and informal moneylenders; and
WMCIP beneficiaries.

Overall, micro-credit is applicable only to the enterprising poor. The application of micro-credit to other
poverty groups who actually need subsidies and social safety nets would be a mistake. Thus, the EDC
sub-component should be reformulated and revitalized following the program design of the Bangladesh
Rural Advancement Committee (BRAC). Its graduated strategy for helping the poor should be applied to
the poverty pyramid by categorizing the WMCIP beneficiaries into four poverty groups: (1) micro-
enterprise operators or the less poor, (2) enterprising or moderately poor, (3) laboring or very poor, and
(4) poorest of the poor and most vulnerable or the ultra-poor.

The results further reveal that based on the poverty pyramid, the credit program designs of the Credit
Assistance Program for Program Beneficiaries Development (CAP-PBD) and Quedan Rural Credit and
Finance Corporation (QUEDANCOR) are readily applicable to the credit needs and financial capabilities
of the enterprising poor. Beyond QUEDANCOR¶s micro-credit facility, the non-enterprising poor may
actually opt for financial assistance from cooperatives or CAP-PBD to help finance their agriculture-and
fishery-related production activities. On the other hand, the beneficiaries and their ³not-so-strongX
organizations that could not readily comply with the minimum credit standards should be provided with
farm production subsidies, capability-building services and social safety nets under a special poverty
alleviation project. This will enable them to pass minimum credit standards within a transition period of six
months to one year.

In view of WMCIP¶s EDC sub-component, the study further identifies the factors that enable or limit
successful design and implementation of micro-credit program and the provision of public support
services. The enabling factors are vital to planning and decision-making that will eventually make the
program effective and appropriate. The limiting factors, on the other hand, facilitate the identification of
strategies to manage and control credit risks and other circumstances that may hinder participation and
adversely affect the attainment of objectives and desired outcomes.

On the whole, the application of good governance will improve program design and will make the
implementation strategies acceptable to all organized stakeholders and individual end-beneficiaries. This
will also improve the administrative capabilities of partner organizations and enable them to be effective
and responsive to the differentiated poverty conditions, credit needs, preferences and financial
capabilities of the impoverished target beneficiaries. These are consequently geared towards the
attainment of the long-term vision of sustainable human development for the impoverished WMCIP
beneficiaries.

The integration of good governance into micro-credit intends to improve its program design,
implementation strategies and processes. However, support services are actually necessary so as to
simultaneously attain the desired social equity and financial viability objectives. The program should be
orchestrated within a comprehensive and integrated approach to poverty reduction and rural
development. The good governance of micro-credit requires multiple organizational partnerships among
the different government agencies, business sector and the civil society. Most importantly, the financial
and technical support programs of the international donor community are absolutely necessary in the light
of Philippine economic and fiscal challenges.

Working Paper Series

À

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Moreno, Frede Gumera, Good Governance of Microcredit Strategy for Poverty Reduction: Focus on Western Mindanao,
Philippines (November 24, 2004). Available at SSRN: http://ssrn.com/abstract=1499495
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